Objective information about financial planning, investments, and retirement plans

Brexit and Your Portfolio

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As you are most likely aware, the U.K. voted to leave the European Union. The so-called Brexit vote was a surprise to many and caused a swift, severe and negative reaction in the world financial markets.

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On Friday June 24, the S&P 500 lost about 3.6% and the Dow Jones Industrial Average lost about 3.4% of its value. There may be more pain in the days ahead, only time will tell.

As an individual investor what should you do when the stock market drops?

This isn’t new 

While the Brexit is a new issue, we’ve seen plenty of market disruptions before. The stock market crash of October 19, 1987 saw the market drop 22.61%. The correction following the Dot Com bust and 9/11 was severe as was the market decline in the wake of the 2008 financial crises. The markets recovered nicely in all cases and even with Friday’s declines the S&P 500 is about three times higher than it was at the depths of the market in March of 2009.

A good time to do nothing 

While everyone’s situation is different, the vast majority of investors would be wise to do nothing in the wake of these market declines. Panicking and withdrawing money from your accounts may feel good now, but you’ll likely regret it down the road.

Investors nearing retirement who sold their equity holdings near the depths of the financial crises in late 2008 or early 2009 realized large losses, then sat on the sidelines during some or all of the ensuing market recovery. Their retirement dreams are in shambles because they panicked.

Some strategies to consider 

Once the dust settles a bit, here are a few things you might consider:

Rebalancing your portfolio. Especially if the markets continue their downward trend for a few more days or weeks it is likely that your portfolio will become underweight in equities. This is a good time to rebalance back to your target asset allocation. Rebalancing forces a level of discipline on investors, in this case buying when equities have fallen.

Tax-loss selling. In the course of rebalancing and reviewing your portfolio, you may have some holdings in your taxable account that have dropped below their cost basis. Look to sell some of them to realize the loss. Be sure to understand the wash-sale rules if you intend to buy these holdings back. Above all ensure that any asset sales make good investment sense, as the saying goes “…don’t let the tax tail wag the investment dog…”

Recharacterize a Roth conversion. If you have converted traditional IRA dollars to a Roth IRA and the value of these converted dollars has fallen you are entitled to a do-over or recharacterization. You generally have until October 15 of the year following the year in which the conversion took place. The assets that are recharacterized cannot immediately be converted back to a Roth, there is generally at least a 30 day waiting period. In other words if you did a conversion in 2015 you would have until October 15, 2016 (or the latest tax filing date including extensions).

If the value of the assets that you converted has fallen appreciably, there can be significant tax savings to be realized here. These rules are complex so be sure that you know what you are doing or that you seek the advice of a knowledgeable tax or financial advisor.

The Bottom Line 

Event-driven market declines such as we’ve seen (and may continue to see) via the Brexit vote are often swift and severe in nature. For most investors the best course of action is no action. Once the dust has settled a bit review your portfolio and make adjustments and tweaks that make sense in a thoughtful, controlled fashion.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out our resources page as well.  

 

The Bull Market Turns Seven Now What?

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On March 9, 2009 the market downturn fueled by the financial crisis bottomed out as measured by the S&P 500 Index. On that day the index closed at 677. Yesterday, on the bull market’s seventh birthday, the index closed at 1,989 or an increase of about 194 percent. According to CNBC the Dow Jones Industrial Average has increased 160 percent and the NASDAQ 267 percent over this seven-year time frame.

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With the bull market turning seven, now what? Here are some thoughts and ideas for investors.

How does this bull market stack up?

According to data from the most recent quarterly Guide to the Markets report from JP Morgan Asset Management, the average bull market following a bear market lasts for 53 months and results in a gain of 153%. By both measures this bull market is a long one.

Does this mean that investors should brace for an imminent market correction? Not necessarily but bull markets don’t last forever either.

There have been some speed bumps along the way, including 2011, a sharp decline in the third quarter of 2015 and of course the sharp declines we saw to start off 2016. Again this is not an indicator of anything about the future.

Winners and losers

A commentator on CNBC cited a couple of big winners in this bull market:

  • Netflix (NFLX) +1,667%
  • General Growth Properties (GGP) +9,964%

Additionally, Apple (APPL) closed at a split-adjusted $11.87 per share on March 9, 2009. It closed at $101.12 on March 9, 2016.

The CNBC commentator cited giant retailer Walmart (WMT) as a stock that has missed much of the bounce in this market, as their stock is up only 42% over this time period.

What should investors do now? 

None of us knows what the future will hold. The bull market may be getting long of tooth. There are factors such as potential actions by the Fed, China’s impact on our markets, the threat of terrorism and countless others that could impact the direction of the stock market. It seems there is always something to worry about in that regard.

That all said, my suggestions for investors are pretty much the same “boring” ones that I’ve been giving since I started this blog in 2009.

  • Control the factors that you can control. Your investment costs and your asset allocation are two of the biggest factors within your control.
  • Review and rebalance your portfolio This is a great way to ensure that your allocation and your level of risk stay on track.
  • When in doubt fall back on your financial plan. Review your progress against your plan periodically and, if warranted, adjust your portfolio accordingly.
  • Contribute to your 401(k) plan and make sure that your investment choices are appropriate for your time horizon and risk tolerance. Avoid 401(k) loans if possible and don’t ignore old 401(k) accounts when leaving a company.
  • Don’t overdo it when investing in company stock.
  • If you need professional financial help, get it. Be sure to hire a fee-only financial advisor who will put your interests first.

The Bottom Line 

The now seven-year bull market since the bottom in 2009 has been a very robust period for investors. Many have more than recovered from their losses during the market decline of 2008-09.

Nobody knows what will happen next. In my opinion, investors are wise to control the factors that they can, have a plan in place and follow that plan.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out our resources page as well.

Denver Wins! Time to Go to Cash?

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The Denver Broncos just won Super Bowl 50 and its looking like Peyton Manning will go out a winner. Good news and a feel good story? Not for investors. The Super Bowl Indicator says a win by an AFC team is a bad omen for the stock market for the year. 

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Super Bowl Indicator

The Super Bowl Indicator says that if a team from the old American Football League (AFL) wins the Super Bowl that the stock market will finish down for the year.

This indicator has held true for 40 of the previous 49 Super Bowls played prior to this one, including the past seven years.

The New York Giants, one of the earliest teams from the NFL, won the Super Bowl in 2008 but as we all recall the stock market had its worst year since the Great Depression with the S&P 500 being down 37% for the year. I guess a little thing like the mortgage fueled financial crises trumps a “sure fire” stock market predictor like the outcome of the Super Bowl.

The January Effect 

The Stock Trader’s Almanac says that if the month of January is down then 75% of the time the stock market will be down for the year.

The January Effect says that stocks that were sold off in December for tax-loss harvesting purposes will rally in January when investors buy them at reduced prices.

With the S&P 500 and the Dow Jones Industrial Average both down over 5% for the month this clearly didn’t happen.

Time to go to cash? 

Clearly investors should not peg their actions to any type of indicator like the Super Bowl Indicator or any of the others of a similar nature that have cropped up over the years.

The best course for investors has always been to have a financial plan, have an investing strategy and stick to their plan.

The Bottom Line 

The Super Bowl Indicator is fun and part of the Super Bowl hype. At the end of the day there is really no correlation between the performance of the stock market and who wins the Super Bowl. Investors should invest based upon their goals, their time horizon and their risk tolerance. I will say this, however. The market will be way up in 2017 after my Green Bay Packers bring the Lombardi Trophy back to its rightful home, Lambeau Field. OK no predictions, I have no idea what the market will do after the Packers win (which is a sure thing, I hope).

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out our resources page as well.

Smart Beta ETFs the Next Big Thing?

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For those of us involved in financial services it is hard to check your Twitter stream or visit an industry website without seeing the term smart beta. ETF providers have really taken to this trend and have introduced many new ETFs based on some aspect of smart beta.

Nobody follows a trend quite like the folks who market mutual funds or ETFs and smart beta is the hip thing that all of the “cool kids” are doing. At a recent ETF industry conference sponsored by Morningstar (MORN) this was virtually all anyone was talking about in the sessions I attended.

What is smart beta and is it really smart?  Are smart beta ETFs the next big thing in ETF investing?

Smart Beta Defined 

According to Investopedia (for whom I am a frequent contributor):

“Investment managers that follow a smart beta investment strategy seek to passively follow indices, while also taking into account alternative weighting schemes such as volatility. That’s because smart beta strategies are implemented like a typical index strategies in that the index rules are set and transparent. Smart Beta strategies will differ from standard indices, such as the S&P 500 or the Barclays Aggregate, in that the indices focus on areas of the market that offer an opportunity for exploitation.” 

We will attempt to expand on that definition a bit below. 

Factor investing 

Most smart beta ETFs take an aspect or a factor from a traditional index. Traditional index ETFs passively track a market value weighted index like the S&P 500.  Some popular factors include low volatility, momentum; equal-weighted indexes, dividends and quality are common factors. An equal-weighted index would give equal weighting to a huge stock like Apple (APPL) and to the smallest stock in terms of market capitalization in the S&P 500 Index.

An example of a smart beta ETF based on a factor is the Powershares S&P 500 Low Volatility ETF (SPLV).

This ETF invests in the 100 stocks in the index that have exhibited the lowest volatility over the past 12 months. A sound idea in theory and perhaps ultimately in practice.

Like many smart beta ETFs the inception date of SPLV was May 5, 2011 over two years after the low point of the markets during the financial crises. The index the ETF follows was essentially created in the lab via back-testing, much like the Peter Boyle character in the movie Young Frankenstein. This means that most of the “history” of this ETF is via back-testing and not real performance data. As a presenter at the Morningstar conference said, he’s never seen a back-test that did not yield a positive result.

Looking at SPLV’s results, the ETF trails the S&P 500 index in terms of trailing three year returns 12.95% to 14.77% on an average annual basis for the period ending 10/19/2015. However for the year-to-date period through the same date SPLV has gained 1.27% versus 0.41% for the index.

Looking at another measure, standard deviation of return which measures the variability of the ETF’s returns (up and down) over the three year period ending 9/30/2015, the standard deviation for SPLV is +/- 9.63% versus +/- 9.74% for the index. My guess is that a selling point of this ETF would be lower volatility but over the past three years the smart beta ETF is only fractionally less volatile than the index and an investor would have considerably less money if they had held SPLV over a more traditional ETF like the SPDR S&P 500 ETF (SPY).

Is an investment in SPLV a bad idea? I don’t know because I have no idea how this ETF will hold up in a pronounced bear market. Yes it has performed better than the full index so far in 2015 including the volatility in August and September. How will it do if we hit a rough patch like 2000-2002 or 2008-2009? Good question.

A growth area 

According to data from Morningstar as of 6/30/2015:

  • There were 444 smart beta products listed in the U.S.
  • These products accounted for $540 billion in assets under management which was 21% of all U.S ETF assets.
  • Of the new cash flows into ETFs over the past 12 months, 31% went into smart beta products.
  • The assets in these products grew 27% over the same period.
  • A quarter of new ETF launches over the past five years were smart beta products.

Who uses smart beta ETFs? 

From what I have heard and read smart beta ETFs are being used largely by financial advisors and institutional investors versus individuals. You might say so what? These folks are likely investing your money either via your relationship with a financial advisor who may use them in a portfolio or use a TAMP (turnkey asset management program) program offered by a third-party to manage your money.

Reasons to use Smart Beta 

Morningstar cites several reasons investors and advisors might consider smart beta ETFs:

  • To manage portfolio risk
  • To enhance portfolio returns
  • For tactical asset allocation, meaning an allocation that is based in part on the advisor’s assessment of market conditions
  • Reducing fees versus actively managed mutual funds
  • To use an active strategy grounded by an index core

Many, including me, view strategic beta as a form of active management. A presenter at the Morningstar conference suggested that any smart beta ETF with an expense ratio of 50 basis points or higher should not be considered as this is the lower end of the fee range for the better actively managed mutual funds offering an institutional share class.

What does this mean for individual investors? 

Again I suspect that most of the money invested here will be institutional or via financial advisors. As an individual investor working with a financial advisor who suggests using smart beta ETFs in your portfolio, you should ask them to explain their rational. Why are these ETFs a better choice than an asset allocation strategy using more traditional index products?

If you will using smart beta ETFs on your own, be sure that you fully understand the underlying index which was likely created post-financial crises via back testing. Understand that smart beta strategies may look good on paper but in reality they can take a number of years to prove themselves.  Lastly understand that strategies that look good in testing may not work as well when millions of dollars are actually invested there real-time.

For financial advisors 

Most financial advisors that I know are very deliberate in testing new products and investing ideas before using them with clients. With the rise of third-party advisors such as TAMPs and ETF strategists, financial advisors still need to understand the underlying products and strategies being used to invest their client’s hard-earned money.

The Bottom Line 

Smart beta is the next evolution of ETF investing or so say the firms trying to gather assets into these products. I’m not saying that smart beta isn’t an enhancement or that I am against new investing inovations. I am leery of any investment vehicle designed to solve a problem or fill a role in portfolios that have not gone through a full stock market cycle. With any investment vehicle that you are considering, be sure to fully understand the benefits, the risks and the costs. How smart is smart beta? We really won’t know until the market goes through a full cycle that includes a significant correction.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out our resources page as well.  

How Much Apple Stock Do You Really Own?

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Apple (AAPL) stock has been a great investment over the years. Based upon its stock price and the number of shares outstanding it is the largest U.S stock based upon market capitalization.  This means it is the largest holding in popular index mutual funds and ETFs like Vanguard 500 (VFINX) and the SPDR S&P 500 ETF (SPY).

Chuck Jaffe recently wrote an excellent piece for Market Watch discussing the impact that a recent drop in Apple stock had on a number of mutual funds that hold large amounts of Apple.  He cited a list of funds that had at least 10% of their assets in Apple.  On a recent day when Apple stock fell over 4% these funds had single day losses ranging from 0.22% to 2.66%.

The point is not to criticize mutual fund managers for holding large amounts of Apple, but rather as a reminder to investors to understand what they actually own when reviewing their mutual funds and ETFs.

Stock overlap 

In the late 1990s a client had me do a review of their portfolio as part of some work I was doing for the executives of the company. He held 19 different mutual funds and was certain that he was well-diversified.

The reality was that all 19 funds had similar investment styles and all 19 held some of the popular tech stocks of the day including Cisco (CSCO), Intel (INTC) and Microsoft (MSFT). As this was right before the DOT COM bubble burst in early 2000 his portfolio would have taken quite a hit during the market decline of 2000-2002.

Understand what you own 

If you invest in individual stocks you do this by choice. You know what you own. If you have a concentrated position in one or more stocks this is transparent to you.

Those who invest in mutual funds and other professionally managed investment vehicles need to look at the underlying holdings of their funds.  Excessive stock overlap among holdings can occur if your portfolio is concentrated in one or two asset classes. This is another reason why your portfolio should be diversified among several asset classes based upon your time horizon and risk tolerance.

As an extreme example someone who works for a major corporation might own shares of their own company stock in some of the mutual funds and ETFs they own both inside their 401(k) plan and outside. In addition they might directly own shares of company stock within their 401(k) and they might have stock options and own additional shares elsewhere. This can place the investor in a risky position should their company hit a downturn that causes the stock price to drop.  Even worse if they are let go by the company not only has their portfolio suffered but they are without a paycheck from their employer as well.

Concentrated stock positions 

Funds holding concentrated stock positions are not necessarily a bad thing. A case in point is Sequoia (SEQUX) which has beaten its benchmark the S&P 500 by an average of 373 basis points (3.73 percentage points) annually since its inception in 1970.  Sequoia currently has about 26% of its portfolio in its largest holding and another 8% in the two classes of Berkshire Hathaway stock.  Historically the fund has held 25-30 names and at one time held about 30% of the portfolio in Berkshire Hathaway (BRK.A).  Year-to-date through August 14, 2015 the fund is up 16.5% compared to the benchmark’s gain of 2.88%.

The Bottom Line 

Mutual fund and ETF investors may hold more of large market capitalization stocks like Apple and Microsoft than they realize due to their prominence not only in large cap index funds but also in many actively managed funds. It is a good idea for investors to periodically review what their funds and ETFs actually own and in what proportions to ensure that they are not too concentrated in a few stocks, increasing their risk beyond what they might have expected.

Not sure if you are invested properly for your situation? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services.  

Why Using Home Equity to Invest in the Stock Market is a Bad Idea

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Not that I needed one but an email newsletter that I received from attorney Dale Ledbetter recently served as an excellent reminder what a poor idea using home equity to invest in stocks really is.  From his email:

Strong stock market encourages the resurrection of a bad practice – borrowing money against the value of your home to play the market. The horror story set out below is likely to be repeated if these practices continue.

A married couple, both of whom were in their late 80s, was persuaded by their bank to take out 100% value equity line of credit against their home. They were then persuaded to turn these “borrowed assets” over to the bank’s securities subsidiary where they were told the return would easily exceed the cost of the credit line. 

The broker then advised the couple to put 95% of the total proceeds into a single stock. The securities account tanked, resulting in an almost 100% loss. In the meantime, the house dropped in value by $100,000, resulting in a foreclosure proceeding. The bank then refused to permit a $150,000 short sale to bona fide buyers. 

The husband died. The wife, who now lives in a constant care facility, is entering bankruptcy to force the bank to take the house. 

Of course, the bank and their securities subsidiary blame it all on the elderly couple who they described as “sophisticated investors.” Both husband and wife had been schoolteachers and had no training or experience in the securities industry or in investment strategies. The fact that both were in their late 80s and suffering from diminished capacity, was not enough to deter the aggressive sales tactics of their “trusted advisors.” 

Aside from what would seem to be blatant investment fraud on the part of the bank and their advisory unit, this piece reiterates why using your home equity to invest in the stock market is such a bad idea.  Here are a few specific reasons that I discourage this practice.

Did you really forget the 2008 housing market crash this soon? 

For those with short memories an overinflated housing market crashed and triggered a meltdown in the economy and drastically reduced the value of many homes.  We are still recovering from this and although home values have improved in many parts of the country we learned that home prices will not always go up and that real estate is not the safe store of value we were led to believe.

To put this another way let’s say you tap your home equity to invest in the stock market.  What if the value of your home decreases 10 percent, 20 percent or more?  Now you have to pay back that home equity loan on a house that isn’t worth nearly as much as when you took out the loan.  You could find yourself underwater on your home or worse in foreclosure.  You could also find that your plans to fund a comfortable retirement or your children’s college education are out the window.

What if your investments tank?

Much like these poor folks in Mr. Ledbetter’s example above, not all investments are a sure thing.  What happens if you borrow against your home equity to invest in the stock market and things don’t work out?  If the specific investments you or someone else chose drop in value you are now stuck with investments worth less than your original investment and you will be stuck paying off the loan which is still based upon the amount borrowed.

Even if you went with a few index funds and the stock market drops you will find yourself in the same boat.  Again this is a great strategy to ruin your otherwise well-planned financial future.

Who exactly is suggesting this idea? 

Like the poor folks in Mr. Ledbetter’s example take a look at anyone suggesting this idea to you with a very jaundiced eye.  What is in it for them?  Are you the only one with any real skin in the game?

In the example above the bank won at last twice.  They got the interest on the loan and their brokerage unit made money via fees and perhaps other sources on the investment side.  They had no skin in the game and will likely come out whole even after the foreclosure.  

The Bottom Line

Generally, in my opinion, anyone who would suggest this idea to an investor is motivated by greed and does not have the best interests of their clients at heart.  Using your home’s equity to invest in the stock market is just not a sound idea.

There might be instances where tapping home equity to invest can be a good idea, but these are very limited and should only be undertaken by truly sophisticated investors who fully understand the risks involved.

Please feel free to contact me with your questions. 

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Are Brokerage Wrap Accounts a Good Idea?

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A reader recently emailed a question regarding a brokerage wrap account he had inherited from a relative.   He mentioned that he was being charged a one percent management or wrap fee and also suspected that he was incurring a front-end load on the A share mutual funds used in the account.

Upon further review we determined that the mutual funds were not charging him a front-end load.  Almost all of the funds being used, however, had expense ratios in excess of one percent plus most assessed 12b-1 fees paid to the brokerage firm as part of their expense ratios.

Are brokerage wrap accounts a good idea for you?  Let’s take a look at some questions you should be asking.

What are you getting for the wrap fee? 

This is the ultimate question that any investor should ask not only about wrap accounts but any financial advice you are paying for.

In the case of this reader’s account it sounds like the registered rep is little more than a sales person who put the reader’s uncle into this managed option.  From what the reader indicated to me there is little or no financial advice provided.  For this he is paying the brokerage firm the one percent wrap fee plus they are collecting the 12b-1 fees in the 0.25 percent to 0.35 percent on most of the funds used in the account.

Before engaging the services of a financial advisor you would be wise to understand what services you should expect to receive and how the adviser and their firm will be compensated.  Demand to know ALL aspects of how the financial advisor will be compensated.  This not only lets you know how much the relationship is costing you but will also shed light on any potential conflicts of interest the advisor may have in providing you with advice.

What’s special about the wrap account? 

While the reader did not provide me with any performance data on the account, from looking at the underlying mutual funds it would be hard to believe that the overall performance is any better than average and likely is worse than that.

Whether a brokerage wrap account or an advisory firm’s model portfolio you should ask the financial advisor why this portfolio is appropriate for you.  Has the performance of the portfolio matched or exceeded a blended benchmark of market indexes based on the portfolio’s target asset allocation?  Does the portfolio reduce risk?  Are the fees reasonable?

What are the underlying investments? 

In looking at the mutual funds used in the reader’s wrap account there were a few with excellent returns but most tended to be around the mid-point of their asset class.  Their expenses also tended to fall at or above the mid-point of their respective asset classes as well.

Looking at one example, the Prudential Global Real Estate Fund Class A (PURAX) was one of the mutual funds used.  A comparison of this actively managed fund to the Vanguard REIT Index Fund Investor shares (VGSIX) reveals the following:

Expense ratios:

PURAX

VGSIX

Expense Ratio

1.26%

0.24%

12b-1 fee

0.30%

0.00%

 

 Trailing returns as of 12/31/14:

1 year

3 years

5 years

10 years

PURAX

14.03%

14.47%

11.12%

6.66%

VGSIX

30.13%

16.09%

16.84%

8.41%

 

While the portfolio manager of the wrap account could argue the comparison is invalid because the Prudential fund is a Global Real Estate fund versus the domestic focus of the Vanguard fund I would argue what benefit has global aspect added over time in the real estate asset class?  Perhaps the attraction with this fund is the 30 basis points the brokerage firm receives in the form of a 12b-1 fee?

Looking at another example the portfolio includes a couple of Large Value funds Active Portfolios Multi-Manager A (CDEIX) and CornerCap Large/Mid Cap Value (CMCRX).  Comparing these two funds to an active Large Value Fund American Beacon Large Value Institutional (AADEX) and the Vanguard Value Index (VIVAX) reveals the following:

Expense ratios:

CDEIX

CMCRX

AADEX

VIVAX

Expense Ratio

1.26%

1.20%

0.58%

0.24%

12b-1 fee

0.25%

0.00%

0.00%

0.00%

 

Trailing returns as of 12/31/14:

1 year

3 years

5 years

10 years

CDEIX

10.01%

NA

NA

NA

CMCRX

13.11%

19.30%

12.98%

5.78%

AADEX

10.56%

21.11%

14.73%

7.57%

VIVAX

13.05%

19.98%

14.80%

7.17%

 

Again one has to ask why the brokerage firm chose these two Large Value funds versus the less expensive institutionally managed active option from American Beacon or the Vanguard Index option.  I’m guessing compensation to the brokerage firm was a factor.

Certainly the returns of the overall wrap account portfolio are what matters here, but you have to wonder if a wrap account uses funds like this how well the account does overall for investors.

The lesson for investors is to look under the hood of any brokerage wrap account you are pitched to be sure you understand how your money will be managed.  I’m not so sure that my reader is being well served and after our email exchange on the topic I hope he has some tools to make an educated evaluation for himself.

The Bottom Line 

Brokerage wrap accounts are an attempt by these firms to offer a fee-based investing option to clients.  As with anything investors really need to take a hard look at these accounts.  Far too many charge substantial management fees and utilize expensive mutual fund options as their underlying investments.  It is incumbent upon you to understand what you are getting in exchange for the fees paid.  Is this investment management style unique and better?  Will you be getting any actual financial advice?

The same cautions hold for advisory firm model portfolios, the offerings of ETF strategists and managed portfolios offered in 401(k) plans.  You need to determine if any of these options are right for you.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

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Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

Tis the Season for Stock Market Predictions

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As I listen to CNBC in the background and read the financial press it is the season for the pundits to make their 2015 stock market predictions.  Some of these predictions relate to the level of the market in general, others include “hot stocks for 2015.”

Many of these people are pretty smart and I’m not dismissing their research.  What I am saying is that that I’m not so sure any of this is useful.  But in the spirit of the season here are my 2015 stock market predictions.

The stock market might go up 

The consensus seems to be that 2015 will be a good year for the stock market.  They might well be right.  The U.S. economy is improving, oil prices are low, etc.

The stock market might go down 

The experts could be wrong or worse there could be some sort of adverse event that spooks the market and perhaps the economy.

My official stock market predication is that I have no clue 

While this is all fun and provides something for the cable news talking heads to discuss, at the end of the day nobody has a clue what 2015 or any year holds for the stock market or the economy.

Focus on what you can control 

We have no control over what the financial markets will do or over how your stocks, mutual funds, ETFs, or any other holdings will do.  But as investors you can control a number of things including:

  • The cost of investment advice
  • The expense ratios of mutual funds and ETFs owned
  • Your asset allocation
  • Your overall investment strategy
  • How much you save and invest in our 401(k) and elsewhere
  • How much you spend.

I’m not denigrating the value of stock market research and analysis.  But for most of you reading this post I’m guessing that you are long-term investors versus being traders.  If that is the case you are, in my opinion, far better off controlling what you can control and investing in line with your financial plan than in trying to chase predictions and hot segments in 2015 or in any year.

Start 2015 out right, check out an online service like Personal Capital to manage all of your accounts all in one place.  Check out our Resources page for more tools and services.

Is the Dow Jones Industrial Average Still a Relevant Stock Market Index?

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The Dow Jones Industrial Average (DJIA) of 30 large stocks has long been arguably the most watched index for those following the stock market.  As I write this IBM a long-time index component reported a major miss in its quarterly earnings.

The stock was down some 7% for the day and due to this decline the DJIA was been down most of the day.  The index finished up some 19 points but without the drag of IBM the index would have been up around 100 points according to a commentator on CNBC.  This begs the question is the Dow Jones Industrial Average still a relevant stock market index?

It’s just 30 stocks 

The DJIA is a weighted average (the actual weighting formula is very complex) of the price of the 30 stocks that comprise the index.  Originally the index was supposed to represent the stocks of large industrial companies.  Over the years the composition of the index has changed to reflect the changing nature of American business.

Here are the 30 companies that comprise the index:

Company

 

 

 

 

 

3M Co
American Express Co
AT&T Inc
Boeing Co
Caterpillar Inc
Chevron Corp
Cisco Systems Inc
E I du Pont de Nemours and Co
Exxon Mobil Corp
General Electric Co
Goldman Sachs Group Inc
Home Depot Inc
Intel Corp
International Business Machines
Johnson & Johnson
JPMorgan Chase and Co
McDonald’s Corp
Merck & Co Inc
Microsoft Corp
Nike Inc
Pfizer Inc
Procter & Gamble Co
The Coca-Cola Co
Travelers Companies Inc
United Technologies Corp
UnitedHealth Group Inc
Verizon Communications Inc
Visa Inc
Wal-Mart Stores Inc
Walt Disney Co

 

Certainly a nice mix of manufacturers, retail, financial services, and technology related companies.  Three major names absent from the index include Google, Facebook, and Apple.  While these are large and influential companies they do not represent the total focus of the investment universe.

Chuck Jaffe wrote this excellent piece on the topic of the Dow It’s time to ditch the Dow Jones Industrial Average  over at the Market Watch site.

Investing options are varied and global 

Of the major market benchmarks the broader S&P 500 seems to hold a lot more sway with many money managers and others in the finance and investing world.  I know that personally I am a lot more concerned with this index as a benchmark for large cap mutual funds and ETFs than the Dow.

The NASDAQ is also widely watched due to its heavy tech influence.  I think the bursting of the Dot Com bubble put this index on the radar to stay back in early 2000.

Other key benchmarks include the Russell 2000 for small cap stocks, the Russell Mid Cap, the EAFE for large cap foreign stocks and many others for various market niches.  Additionally there are any number of index mutual funds and ETFs that follow these and other key benchmarks for those who want to invest in these segments of the stock market.

While I’m guessing the Dow will remain a widely watched and quoted stock market indicator I and many others find it increasingly irrelevant.  It is always a good idea to benchmark your investments against the appropriate index for a single holding or a blended, weighted benchmark to gauge your overall portfolio’s performance.

New Money Market Rules – How Will They Impact You?

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The Securities and Exchange Commission (SEC) recently passed new rules governing money market funds.  These rules are designed to combat liquidity problems should the economy experience another period of crisis such as in 2008.

New Money Market Rules – How Will They Impact You?

I’ve read a few articles on this issue but I do not claim to fully understand all of the implications for investors.  I will likely do a follow-up to this post at some point in the future when I know a bit more. Here are a few items from these new money market rules that might impact you.  You might also check out this excellent piece by Morningstar’s John Reckenthaler.

Floating NAV – Institutional Money Market Funds 

For institutional money market funds the stable $1 net asset value (NAV) per share will be gone.  The NAV of these funds will be priced out to four decimal places and will be allowed to float.  Your shares may be worth more or less than what you paid for them upon redemption.

Again this applies to institutional money market funds.  Retail money market funds, defined as funds owned by natural persons, along with government and Treasury-based money funds will retain their stable $1 NAV.  From what I have been told, money market funds owned by participants within a 401(k) or similar retirement plan are considered to be retail funds as well.  I’m not quite as sure with regard to an institutional share class money market fund held by an individual investor.

Liquidity Fees and Redemption Gates 

Both retail money market funds, again excluding funds investing in government and Treasury instruments and institutional funds, will be subject to liquidity fees and redemption gates (restrictions) under certain circumstances.

  • If liquid assets fall below 30%, a fund’s board may impose a 2% fee on redemptions.  This is at their discretion.
  • If liquid assets fall below 10%, a fund’s board must impose a 1% fee on redemptions.  This fee is mandatory under the new rules.
  • If liquid assets fall below 30%, a fund’s board may suspend redemptions from the fund for up to 10 days. 

How will these new money market rules impact you? 

Money market funds will have two years from the date the final SEC rules appear in the Federal Register to be in compliance with the floating NAV, liquidity fee, and redemption gate rules.

According to Benefits Pro:

“Nearly $3 trillion is invested in money-market funds. As of July 3, 2014, more than $800 billion was held in the institutional money-market funds affected by today’s reforms, according to the SEC.” 

Among the main users of institutional money market funds would be pension plans, foundations, and endowments.  They will be the ones directly impacted by the change to a floating rate NAV; however the beneficiaries of these funds will ultimately be impacted should this change have a negative impact on the underlying portfolio.

The liquidity fees and redemption gates will directly impact individual investors.

A 1% or 2% fee on redemptions would be quite a hit to your balance, especially if viewed in terms of today’s interest rates on money market funds in the range of 0.01%.

The ability to delay redemptions up to 10 days could also have an impact especially if you had written a check off of that account to pay your mortgage or some other bill.

The true test will be if we experience the extreme conditions like those that marked the 2008-09 economic down turn.  None the less as an investor it would behoove you to ask your bank, custodian, or financial advisor how these changes might impact any money market funds you hold and also if it makes sense to switch to another cash option.

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